Prepare to muddle through next year

While most talking heads are predicting a global financial catastrophe next year, the facts point to an unmemorable below-average year

By Barry Eichengreen

Illustration: Mountain People

Nowadays there is no shortage of pundits, economic or otherwise, warning of impending disaster. If right, they are hailed as seers; if wrong, chances are that no one will remember. So here is a forecast: There will be no shortage of predictions that next year is shaping up as a disastrous year.

My view is different: Next year will not be a year of crisis, but nor will it bring an end to our current economic troubles. Rather, it will be a year of muddling through.

Many people think that next year will be the make-or-break year for Europe — either a quantum leap in European integration, with the creation of a fiscal union and the issuance of eurobonds, or the eurozone’s disintegration, igniting the mother of all financial crises.

In fact, neither scenario is plausible. The collapse of the eurozone would, of course, be an economic and financial calamity. However, that is precisely why the European Central Bank will overcome its reluctance and intervene in the Italian and Spanish bond markets, and why the Italian and Spanish governments will, in the end, use that breathing space to complete the reforms that the bank requires as a quid pro quo.

To be sure, Europe will not be spared the pain of a recession. A botched bank-recapitalization plan and the cloud of uncertainty hanging over the euro mean that recession is already baked in. Moreover, the pro-growth reforms needed in countries such as Italy will almost certainly make things worse before they make them better. For example, the initial effect of reducing hiring and firing costs will be layoffs of redundant workers. However, investors look ahead, so reforms that promise an eventual return to growth should reassure them.

While the eurozone is unlikely to collapse next yeear, there will be no definitive answer to the question of whether the euro will survive because there will be no quantum leap in European integration. Treaty revisions take time to draft — and more time to ratify. For example, efforts to strengthen Europe’s fiscal rules will take the form of bilateral agreements between governments, rather than changes in the EU’s Lisbon Treaty.

It is a sad state of affairs when a recession qualifies as muddling through. However, such is the European condition.

Consider next the US. While recent data suggest that the economy is doing better — all signs are that GDP will have expanded at a 3 percent annual rate in the fourth quarter of this year — it is important not get carried away. Fiscal support for the expansion will continue to be withdrawn. And, while the housing market shows some signs of stabilizing, prices will remain weighed down by the large shadow inventory of homes in foreclosure and held by banks.

These considerations suggest that the acceleration of US growth that began in the third quarter of this year is unlikely to be sustained. At the same time, if growth slows significantly, the US Federal Reserve will undoubtedly respond with another round of quantitative easing — QE3 by another name. Thus, while growth next year is likely to fall well short of 3 percent, the US should be able to avoid a double-dip recession.

Finally, China should grow by 7.5 percent to 8 percent next year. This is muddling through, Chinese style —considerably slower growth than the double-digit rates of the past, but not the hard landing that purveyors of doom and gloom warn is inevitable.